by Roger Bourke White Jr., copyright July 2015
The Optimal Market is an economic concept. It is the condition when a market has the following:
o Perfect market information
o No participant with market power to set prices
o Non intervention by governments
o No barriers to entry or exit
o Equal access to factors of production
o Profit maximization
o No externalities
When a real world market is close to Optimal, it will adapt quickly to changing dynamics surrounding the marketplace and produce prices that are always close to the equilibrium price.
When a market is not acting close to Optimal for some reason, it is called a Market Failure. Then the prices being charged in the market will diverge widely from optimal. The more the market is failing, the wider the divergence.
Here are more details.
All the participants in the market have access to all the relevant information that drives pricing in this marketplace.
Failure: Failure happens when some of the players are keeping secrets, intentionally or unintentionally. The less information that reaches the marketplace, the more guessing goes into the pricing.
No single or small group of players in the market can dictate prices for the whole marketplace.
Failure: When a single player or small group of players can collude and set prices, the market is failing.
No government regulates the marketplace by setting prices or limiting the availability of suppliers, customers or products.
Failure: Government agencies dictate prices or quantities in one way or another. They can overtly set prices, or they can set quality or quantity standards of various sorts.
Customers and providers can come and go as they please.
Failure: There are restrictions on entering or leaving the marketplace. An example of an entering restriction is requiring a certification to participate. An example of an exit restriction is requiring employees to sign non-compete agreements to get a job.
The suppliers to this marketplace have equal access to what it takes to produce products for the marketplace.
Failure: When there is collusion on providing vital components needed to produce products for the marketplace, then this is a barrier to entry and optimal pricing.
The suppliers are in the marketplace to maximize their profits, while the customers are in the marketplace to keep their purchasing costs as low as they can.
Failure: When pricing is being determined by other factors than profit maximizing. An example being taking social justice into consideration as part of the pricing determination.
There are no factors that influence the prices in the marketplace that are not being taken into account in the marketplace prices.
Failure: When there are externalities. These can be either positive or negative. A negative externality would be producing pollution in addition to product. A widely experienced positive is free parking.
Externalities are usually taken for granted -- participants in the market rarely think twice about them... until someone suggests they be included in the market structure. Then there is a lot of belly-aching done by many of the participants. Using the free parking as an example, take that away and a lot of participants will complain vigorously, until they take the new condition for granted.
Real world marketplaces are not Optimal -- some come close, some remain quite distant. The closer a real world marketplace is to Optimal, the faster it can adapt to changes in supply and demand.
The disadvantage of being optimal is that other social interests, such as social justice and negative externalities, are not taken into account as the market functions.
--The End--